Explainer

IMF Says India Will Be Fastest Growing Economy in 2021, And That’s Good News, But…

The International Monetary Fund (IMF) in the World Economic Outlook update for January 2021, has forecast that the Indian economy will grow by 11.5% in 2021.

If this happens, it will be the fastest that the Indian economy has ever grown. It will also be the first time that the Indian economy will grow in double digits. (Actually, the country did grow by greater than 10% in 2010-11, but that was later revised by the Modi government, once a new set of gross domestic product (GDP) data was published).

The following chart plots the GDP growth over the years. The GDP is the measure of an economic size of a country.

Source: Centre for Monitoring Indian Economy.

It is interesting that the Indian GDP has grown by more than 9% only twice previously, and both these occasions were before the 1991 economic reforms. The economy grew by 9.15% in 1975-76 (post the first oil shock) and 9.63% in 1988-89. Post 1991, the country grew the fastest in 1999-00 when it had grown by 8.85% (after the American sanctions).

Also, among the selected economies for which IMF published data, India will be the fastest growing economy in the world in 2021. China comes in second at 8.1%.


Source: International Monetary Fund.

India growing by 11.5% in 2021 is indeed a big deal, there is no denying that. But there are a few factors that need to be kept in mind here.

First and foremost is the base effect. Before I go into highlighting the base effect in this context, let’s first understand what it means.

Let’s say the price of a stock in 2019 was Rs 100. In 2020, it falls by 50% to Rs 50. In 2021, it is expected to rise to Rs 75. This means a gain of Rs 25 or 50% per share. If we just look at prices of 2020 and 2021, the stock has done fantastically well and gained 50%.

But what we also need to keep in mind is the stock price in 2019, when it was at Rs 100. It then fell massively by 50% to Rs 50 and rose from there. Hence, the stock price rose from a much lower-base. And this lower base was responsible for a gain of 50%. Further, in 2021, the stock continued to be lower than its 2019 price. This is base effect at play.

One way to look at base effect is to look at the GDP growth/contraction forecast by IMF for 2020.

Source: International Monetary Fund.

As can be seen from the above chart, the IMF expects the Indian GDP to have contracted by 8% in 2020. Hence, in 2020, the Indian economy will be among the worst performing economies in the world. Given this, a 11.5% growth in 2021, will come on a massively contracted GDP in 2020. This is a point that needs to be kept in mind.

Also, all the countries which have done worse than India have a per capita income larger than that of India. In that sense they are economically much more developed than India is and their pain of contraction is much lesser than that of India, given that these countries already have access to the most basic economic necessities in life, which many Indians still don’t.

Let’s go into a little more detail on this point. While the IMF publishes real GDP growth data (which we have been discussing up until now), it doesn’t publish constant price GDP, which adjusts for inflation, in a common currency like the US dollar.

To get around this problem, let’s use the constant price GDP data published by the World Bank. On this we apply, the  GDP contraction/growth rates as forecast by the IMF. As per the World Bank, the Indian GDP in 2019 (in constant 2010 $) was $2.94 trillion. In 2020. A contraction of 8% in 2020 would mean a GDP of $2.70 trillion in 2020. A 11.5% rise on this would mean that the Indian GDP is expected to touch $3.01 trillion in 2021, which is around 2.4% better than the GDP in 2019.

Hence, in that sense, the slowing Indian economic growth for the last few years, followed by the covid contraction, has put the Indian economy back by two years. Of course, it can be argued that every country has gone through this. Indeed, that’s true, but that doesn’t make our pain any better.

Also, before saying stuff like India will grow faster than China in 2021, please keep in mind the fact that the Chinese GDP in 2019 was $11.54 trillion (World Bank data), which is much more than that of the India’s GDP.

In 2020, the Chinese economy was expected to grow by 2.3%. This means that the Chinese GDP in 2020 would have grown to $11.81 trillion. In 2021, the Chinese GDP is expected to grow by 8.1% to $12.76 trillion. This means an increase in GDP of $0.95 trillion in just one year. If we compare this increase with the expected Indian GDP of $3.01 trillion in 2021, what it means is that China will end up adding 31.6% of the India’s economy in just one year. Or to put it simply, China will add a third of India’s economy in just one year.

It also means that between 2019 and 2021, the Chinese economy is expected to grow by $1.22 trillion ($12.76 minus $11.54 trillion). During the same period, the Indian economy is expected to grow by $ 0.07 trillion ($3.01 trillion minus $2.94 trillion). Please keep these facts in mind before saying that in 2021 India will grow faster than China.

Between 2019 and 2021, the gap between India and China has grown even bigger and that is a fact that needs to be kept in mind. All numbers and figures need some context, otherwise they are useless and as good as propaganda, which I think will happen quite a lot during the course of the day today.

If you have already read the newspapers and the websites on this issue, you might have seen that almost all of them say that India will grow faster than China in 2021. But almost  no one bothers to mention the fact that China grew faster than India both in 2019 and 2020. Or the fact that China is growing on a significantly larger base (the most important point when we are talking percentages).

At the risk of repetition, you won’t see any such analysis appearing in the mainstream media. So, kindly continue supporting my work. Even small amounts make a huge difference.

Indian Banks Will Have Rs 17-18 Lakh Crore Bad Loans By September

The Reserve Bank of India (RBI) publishes the Financial Stability Report (FSR) twice a year, in June and in December. This year the report wasn’t published in December but only yesterday (January 11, 2021).

Media reports suggest that the report was delayed because the government wanted to consult the RBI on the stance of the report. For a government so obsessed with controlling the narrative this doesn’t sound surprising at all.

Let’s take a look at the important points that the FSR makes on the bad loans of banks and what does that really mean. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

1) The bad loans of banks are expected to touch 13.5% of the total advances in a baseline scenario. Under a severe stress scenario they are expected to touch 14.8%. These are big numbers given that the total bad loans as of September 2020 stood at 7.5% of the total advances. Hence, the RBI is talking of a scenario where bad loans are expected to more or less double from where they are currently.

2) Under the severe stress scenario, the bad loans of public sector banks and private banks are expected to touch 17.6% and 8.8%, respectively. This means that public sector banks are in major trouble again.

3) In the past, the RBI has done a very bad job of predicting the bad loans rate under the baseline scenario, when the bad loans of the banking system were going up.

Source: Financial Stability Reports of the RBI.
*The actual forecast of the baseline scenario was between 4-4.1%

If we look at the above chart, between March 2014 and March 2018, the actual bad loans rate turned out to be much higher than the one predicted by the RBI under the baseline scenario. This was an era when the bad loans of the banking system were going up year on year and the RBI constantly underestimated them.

4) How has the actual bad loans rate turned out in comparison to the bad loans under severe stress scenario predicted by the RBI?

Source: Financial Stability Reports of the RBI.
*The actual forecast of the baseline scenario was between 4-4.1%

In four out of the five cases between March 31, 2014 and March 31, 2018, the actual bad loans rate turned out higher than the one predicted by the RBI under a severe stress scenario. As Arvind Subramanian, the former chief economic advisor to the ministry of finance, writes in Of Counsel:

“In March 2015, the RBI was forecasting that even under a “severe stress” scenario— where to put it colourfully, all hell breaks loose, with growth collapsing and interest rates shooting up—NPAs [bad loans] would at most reach about Rs 4.5 lakh crore.”

By March 2018, the total NPAs of banks had stood at Rs 10.36 lakh crore.

One possible reason can be offered in the RBI’s defence. Let’s assume that the central bank in March 2015 had some inkling of the bad loans of banks ending up at around Rs 10 lakh crore. Would it have made sense for it, as the country’s banking regulator, to put out such a huge number? Putting out numbers like that could have spooked the banking system in the country. It could even have possibly led to bank runs, something that the RBI wouldn’t want.

In this scenario, it perhaps made sense for the regulator to gradually up the bad loans rate prediction as the situation worsened, than predict it in just one go. Of course, I have no insider information on this and am offering this logic just to give the country’s banking regulator the benefit of doubt.

5) So, if the past is anything to go by, the actual bad loans of banks when they are going up, turn out to be much more than that forecast by the RBI even under a severe stress scenario. Hence, it is safe to say that by September 2021, the bad loans of banks will be close to 15% of advances, a little more than actually estimated under a severe stress scenario.

This will be double from 7.5% as of September 2020. Let’s try and quantify this number for the simple reason that a 15% figure doesn’t tell us about the gravity of the problem. The total advances of Indian banks as of March 2020 had stood at around Rs 109.2 lakh crore.

If this grows by 10% over a period of 18 months up to September 2021, the total advances of Indian banks will stand at around Rs 120 lakh crore. If bad loans amount to 15% of this we are looking at bad loans of Rs 18 lakh crore. The total bad loans as of March 2020 stood at around Rs 9 lakh crore, so, the chances are that bad loans will double even in absolute terms. If the total advances grow by 5% to around Rs 114.7 lakh crore, then we are looking at bad loans of around Rs 17.2 lakh crore.

6) The question is if this is the level of pain that lies up ahead for the banking system, why hasn’t it started to show as yet in the balance sheet of banks. As of March 2021, the RBI expects the bad loans of banks to touch 12.5% under a baseline scenario and 14.2% under a severe stress scenario. But this stress is yet to show up in the banking system.

This is primarily because the bad loans of banks are currently frozen as of August 31, 2020. The Supreme Court, in an interim order dated September 3, 2020, had directed the banks that loan accounts which hadn’t been declared as a bad loan as of August 31, shall not be declared as one, until further orders.

As the FSR points out:

“In view of the regulatory forbearances such as the moratorium, the standstill on asset classification and restructuring allowed in the context of the COVID-19 pandemic, the data on fresh loan impairments reported by banks may not be reflective of the true underlying state of banks’ portfolios.”

The Supreme Court clearly needs to hurry up on this and not keep this hanging.

7) Delayed recognition of bad loans is a problem that the country has been dealing with over the last decade. The bad loans which banks accumulated due to the frenzied lending between 2004 and 2011, were not recognised as bad loans quickly enough and the recognition started only in mid 2015, when the RBI launched an asset quality review.

This led to a slowdown in lending in particular by public sector banks and negatively impacted the economy. Hence, it is important that the problem be handled quickly this time around to limit the negative impact on the economy.

8) Public sector banks are again at the heart of the problem. Under the severe stress scenario their bad loans are expected to touch 17.6% of their advances. The sooner these bad loans are recognised as bad loans, accompanied with an adequate recapitalisation of these banks and adequate loan recovery efforts, the better it will be for an Indian economy.

9) At an individual level, it makes sense to have accounts in three to four banks to diversify savings, so that even if there is trouble at one bank, a bulk of the savings remain accessible. Of course, at the risk of repetition, please stay away from banks with a bad loans rate of 10% or more.

To conclude, from the looks of it, the process of kicking the bad loans can down the road seems to have started. There is already a lot of talk about the definition of bad loans being changed and loans which have been in default for 120 days or more, being categorised as bad loans, against the current 90 days.

And nothing works better in the Indian system like a bad idea whose time has come. This is bad idea whose time has come.

 

Why RBI’s Monetary Policy Has Been a Bigger Flop Than Bombay Velvet

Mere paas kothi hai na car sajni,
Kadka hai tera dildar sajni.
— Rajkavi Inderjeet Singh Tulsi, Ravindra Jain, Kishore Kumar, Asha Bhonsle and Ashok Roy, in Chor Machaye Shor.

Okay, I didn’t have to wait for the Reserve Bank of India’s monetary policy declared today, to write this piece. I could have written this piece yesterday or even a month back. But then the news cycle ultimately determines the number of people who end up reading what I write, and one can’t possibly ignore that.

A few hours back, the Monetary Policy Statement was published by the RBI, after the monetary policy committee (MPC) met on 2nd, 3rd and 4th December. The MPC of the Reserve Bank of India (RBI) has the responsibility to set the repo rate, among other things. The repo rate is the interest rate at which the RBI lends to banks, and which to some extent determines the interest rates set by commercial banks for the economy as a whole.

The MPC has been driving down the repo rate since January 2019, when the rate was at 6.5%. The rate had been cut to 5.15% by February 2020, around the time the covid pandemic struck.

By May 2020, the MPC had cut the repo rate further by 115 basis points to an all-time low of 4%. One basis point is one hundredth of a percentage. The idea behind the cut was two-fold.

In the aftermath of the covid pandemic as the economic activity crashed, the tax collections of the government crashed as well, leading to a situation where the government’s borrowing requirement jumped from Rs 7.8 lakh crore to Rs 12 lakh crore.

The massive repo rate cut would help the government to borrow more at lower interest rates. The yield or the return on a ten-year government of India bond in early February was at 6.64%. Since then it has fallen to around 5.89% as of December 4. The government of India borrows by selling bonds. The money that it raises helps finance its fiscal deficit or the difference between what it earns and what it spends.

The second idea was to encourage people to borrow and spend more and businesses to borrow and expand, at lower interest rates. Take a look at the following chart. It plots the average interest at which banks have given out fresh loans over the years.

Source: Reserve Bank of India.

The data on average interest at which banks have given out fresh loans is available for a period of a little over six years, starting from September 2014 and up to October 2020. It can be seen from the above chart that the interest rates in the recent months, have been the lowest in many years. But has that led to an increase in lending by banks, that’s the question that needs to be answered?

As of October 2020, the total outstanding non-food credit of banks by economic activity, had gone up by 5.6% in comparison to October 2019. Banks give loans to the Food Corporation of India and other state procurement agencies to buy rice, wheat and a few other agricultural products directly from farmers. Once we subtract these loans out from the overall loans given by banks that leaves us with non-food credit by economic activity.

Also, it needs to be mentioned here that this is how banking data is conventionally reported, in terms of the total outstanding loans of banks.

When you compare this with how other economic data is reported, it’s different. Let’s take the example of passenger cars.

When passenger car sales are reported, what is reported is the number of cars sold during a particular month and not the total number of cars running in India at that point of time. In case of banks, precisely the opposite thing happens.

What is conventionally reported is the total outstanding loans at any point of time and not the loans given incrementally during a particular period. So, the total outstanding non-food credit of Indian banks by economic activity, as of October end 2020 stood at Rs 92.13 lakh crore. This increased by 5.6% over October 2019.

The way this data is reported does not tell us the gravity of the situation that the banks are in. That comes out when we look at just incremental loans from one year back. The way to calculate this is to take total outstanding loans as of October 2020 and subtract that from outstanding loans of banks as of October 2019. The difference is incremental loans for October 2020. Similarly, the calculation can be done for other months as well.

Let’s take a look incremental loans data over the last three years.

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As can be seen the above chart, the incremental loans every month in comparison to the same month last year, have been falling since late 2018, just a little before the RBI started cutting the repo rate. In October 2020, they stood at Rs 4.83 lakh crore, a three-year low.

What does this mean? It means that as the MPC of the RBI has gone about cutting the repo rate, the incremental loans given by banks have gone down as well. This is the exact opposite of what economists and central banks expect, that as interest rates fall, borrowing should go up.

And this has been happening from a time before the covid-pandemic struck. Covid has only accentuated this phenomenon. This also leads to the point I make often that for people to borrow more, just lower interest rates are not enough.

The main point that encourages people and businesses to borrow more is the confidence in their economic future. While the government will try and blame India’s currently economic problems totally on covid, it is worth mentioning here that India’s economic growth has seen a downward trend since March 2018. The economic growth for the period January to March 2018 had stood at 8.2% and has been falling since, leading to a lesser confidence in the economic future, both among individuals and corporates.

In fact, if we compare the situation between March 27, 2020, when covid first started spreading across India, and November 6, 2020, the total outstanding non-food credit of banks has grown by just Rs 2,221 crore (yes, you read that right, and this is not a calculation error).

During the same period, the total deposits of banks have grown by Rs 8.13 lakh crore or 6%. The incremental credit deposit ratio between March 27 and November 6, is just 0.27%. We can actually assume it be zero, given that it is so close to zero. Al these deposits have primarily been invested in government bonds.

Basically, on the whole, the banks have been unable to lend any of the deposits they have got from the beginning of this financial year. Only one part of banking is in operation. Banks are borrowing, they are not lending.

What does this tell us? It tells us that banking activity in the country has collapsed post covid, despite the RBI cutting the repo rate to an all-time low-level of 4%, where it’s 361 basis points lower than the latest rate of retail inflation of 7.61%. Other than cutting the repo rate, the RBI has also printed a lot of money and pumped it into the financial system, to drive down interest rates.

But despite that people and businesses are not borrowing. RBI’s monetary policy has been an even bigger flop than Anurag Kashyap’s Bombay Velvet, Raj Kapoor’s Mera Naam Joker and Satish Kaushik’s Roop ki Rani Choron ka Raja. (I name three different films so that readers of different generations all get the point I am trying to make here).

In the monetary policy statement released a few hours back, there is very little mention of this, other than:

“A noteworthy development is that non-food credit growth accelerated and moved into positive territory for the first time in November 2020 on a financial year basis .”

The governor’s statement has some general gyan like this:

“In response to the COVID-19 pandemic, the Reserve Bank has focused on resolution of stress among borrowers, and facilitating credit flow to the economy, while ensuring financial stability.”

No explanations have been offered on why the monetary policy has flopped. The current dispensation at India’s central bank is getting used to behaving like the current government.

It is important to understand here why monetary policy has been such a colossal flop this year. The answer lies in what the British economist John Maynard Keynes called the paradox of thrift. When a single individual saves more, it makes sense, as he prepares himself to face an emergency where he might need that money.

But when the society as a whole saves more, as it currently is, that causes a lot of damage because one’s man spending is another man’s income. As we have seen bank deposits during this financial year have gone up Rs 8.13 lakh crore or 6%. On the whole, people are cutting down on their spending and saving more for a rainy day.

The psychology of a recession at play and not just among those people who have been fired from their jobs or seen a fall in their income. It is obvious that such people are cutting down on their spending. But even those who haven’t faced any economic trouble are doing so.

They are doing so in the fear of seeing a fall in their income or losing their job and not being able to find a new one. When the individuals are cutting down on their spending, it doesn’t make much sense for businesses to borrow and expand. In fact, the overall bank lending to the industry sector has contracted by Rs 4,624 crore between October 2019 and October 2020.

Typically, in a situation like this, when the private sector is not in a position to spend, the government of the day steps in. The trouble is that the current government is not in a position to do so as tax revenues have collapsed this year. There other fears at play here as well.

In the midst of all this, Dinesh Khara, the chairman of the State Bank of India told the Business Standard, that bank lending rates “have actually bottomed”. Given that banks have barely lent anything this year, it makes me sincerely wonder what Mr Khara has been smoking. Clearly, it makes sense to avoid that.

To conclude, monetary policy should not get the kind of attention it gets in the business media, simply because, it is dead, and it has been dying for a while. The trouble is, there are one too many banking correspondents and even more central bank watchers, including me, who need to make a living.

And very few among us, are likely to ask the most basic question—why monetary policy is not working.

Le jayenge le jayenge dilwale dulhaniya le jayenge
— Rajkavi Inderjeet Singh Tulsi, Ravindra Jain, Kishore Kumar, Asha Bhonsle and Ashok Roy, in Chor Machaye Shor.

 

The Real Story Behind India’s Two Wheeler Sales or Rather the Lack of It

Two wheeler sales are a widely used economic indicator. They give us a good indication of the prevailing spending capacity of the middle class. To put it in simpler words, is the middle class in the mood to borrow and spend money or simply spend money (given that everyone doesn’t take a loan to buy a two-wheeler).

In the last few months, several economists, analysts, journalists, politicians and many Twitter warriors, have cited robust domestic two wheeler sales data to tell us lesser mortals that the economy is well on its way to revival.
But is that really the case?

Two wheeler sales data are reported in two ways. The industry body Society of Indian Automobile Manufacturers (SIAM) publishes sales data every month. The Federation of Automobile Dealers Associations (FADA) also publishes this data every month.

The manufacturers produce the two wheelers and the dealers sell them to the end consumers.

Let’s take a look at the following graph which basically plots domestic sales of two wheelers as reported by SIAM and FADA, for this financial year.

What’s that GAP?

Source: SIAM and FADA.

As can be seen from the chart, there is a wide difference in sales as reported by SIAM and as reported by FADA (The blue bar is bigger than the orange bar throughout). Why is this the case? Let’s look at this pointwise.

1) The only month where SIAM and FADA reported same sales was in April, when the economy was under a lockdown, and the two wheeler sales reported by both the bodies was zero.

2) While both the bodies report sales, what they report are totally different numbers. SIAM reports the number of units of two-wheelers leaving the gates of manufacturers or factory gate shipments. In simpler words, these are units which have been sold by manufacturers to dealers across the country, who in turn will sell to the end consumers.

In turn, FADA reports the number of units of two wheelers registered at the Regional Transport Offices (RTOs) across the country after they have been sold to the end consumer. Hence, the sales number reported by FADA is a better representation of sales to end consumers.

3) As can be seen from the chart, in every month from May to October, two wheeler sales as reported by SIAM were more than that reported by FADA. As per SIAM a total of 8.04 million units of two-wheelers were sold during the period April to October 2020, or the first seven months of this financial year. This is around 29.8% lower than sales reported by SIAM during the same period last year. Clearly, year on year sales are down even as per SIAM data.

4) As per FADA, the two wheeler sales during the period April to October stood at 4.78 million units, which is 3.26 million units or 40.5% lower than the number reported by SIAM. Cleary, there is a huge difference between the two numbers. One reason for this lies in the fact that the FADA data still does not capture registrations made at RTOs all offices across the country. The states of Andhra Pradesh, Madhya Pradesh and Telangana, are not hooked on to the Vahan 4 system from which FADA draws its data.

This explains a part of the discrepancy but it’s still not good enough to explain the difference of 3.26 million units in the data  between SIAM and FADA.  The difference was more than a million units in October.

5) Why is the difference so huge? What SIAM is counting as sales is essentially inventory getting built up at their dealer level, something that the FADA data does not capture. This explains a bulk of the difference. A good proportion of the two wheeler units which have been sent from manufacturers to the dealers have not been sold to the end consumer.

Companies have been building up inventory with dealers across the country in the hope of good festival season sales. Also, the new Bharat Stage VI emission norms came into force from April 1. This meant that the inventory of two-wheelers at the dealer level had to be built all over again.

In fact, in its October press release, FADA pointed out that the inventory at the dealer level was at its highest in this financial year and it may impact the financial health of the dealers. In September, FADA had pointed out: “Inventory for two wheelers stands at 45-50 days”. It has only gone up since then.

6) Has this strategy of companies piling up inventory at dealer level in the hope of festive season sales worked? The answer to this question will become clearer once we get the November data from both SIAM and FADA, early next month.

Hero Motorcorp has put out a press release saying it has had a good festival season.  As the company points out:

“Despite the severe disruptions on account of the Covid-19 this year, the good retail off-take during the 32-day festival period – spread between the first day of Navratra and the concluding day after Bhai Duj – was 98% of the festive season volumes sold by the Company in the previous year (2019) and 103% compared to the same period in 2018.”

The question is does this apply to the sector as a whole or has Hero Motorcorp simply been gaining market share? The festival season this year was from around the middle of October to the middle of November. The October data as we have already seen hasn’t really been inspiring on the end consumer sales front with a gap of more than a million units in the sales data as reported by SIAM and FADA.

To conclude, two wheeler sales this year have been weak. As we have already seen, they are down 29.8% year on year, as per SIAM. As per FADA, they are down close to 40.3% year on year. This is the real picture of two-wheeler sales in the country and not the one several economists, analysts, journalists, politicians and many Twitter warriors, have been citing to us lesser mortals.

Of course, things may have improved a tad in November due to the Diwali festival. But will that be good enough to pull the industry out of the mess that it currently is in? I have my doubts about that. Also, in the months to come, the pent up demand will get exhausted. Further, one reason people are buying two wheelers these days is to avoid travelling by public transport. This is likely to have played out by the end of the year.

It will be interesting to see what happens next. Meanwhile, it is safe to say that a large part of the great Indian middle class isn’t really in the mood to spend currently like they did in the past.

Why Large Parts of North India Turn Dystopian Every Winter

Pic by Neil Palmer (CIAT). Burning of rice residues in SE Punjab, India, prior to the wheat season.
— Picture by Neil Palmer (CIAT). Burning of rice residues in Punjab, India, prior to the wheat season.

In the end, it’s all about incentives, perverse or otherwise.

My parents moved to Delhi in 2009, after my father retired from Coal India. Since then I have spent all Diwalis in Delhi, though this Diwali due to reasons beyond my control, I will most probably be in Mumbai.

The last few Diwalis in Delhi have been very difficult for me. In fact, last year, I could smell smoke inside the house even before the Diwali day (so, it was clearly not because of crackers). Delhi and many other parts of North India go totally dystopian during winters.

On some days when one gets up and looks out of the window, there is so much smog that one gets a feeling that Armageddon is here.

One of the primary reasons for this smog/pollution is the rice stubble burning that happens in Punjab, Haryana, parts of Uttarakhand and Western Uttar Pradesh. From the looks of it, the situation doesn’t seem to be very different this year.

Newsreports suggest that stubble burning is currently on and was responsible for 40% of Delhi’s pollution on November 1, the highest it has been so far this season. Last year on the same day, the stubble burning’s contribution to Delhi’s pollution had stood at 44% on November 1.

Let’s try and understand this issue in detail and why it happens every year.

This is a great story of how noble intentions on part of politicians and bureaucrats (yes, you read that right) along with incentives that seem right when they are introduced, can really screw up things in the years to come.

And once a system is in place, right or wrong, it is difficult to change it, given that many individuals benefit from the status quo.

Why do farmers burn rice paddy stubble?

They do it primarily because the time farmers have between harvesting rice paddy and sowing the wheat crop, is very short. That’s the short answer. But there is a lot more to it than just this.

Mechanical harvesters found their way into Punjab sometime in the early 1980s. Around four-fifths of the rice crop is harvested using combine harvesters and not human beings (if you still thought humans being carry out harvesting in Punjab, you haven’t moved beyond Hindi cinema of the 1960s).

These harvesters cut and clean rice from the rice paddy, but they leave behind straws on the field. These straws are six to eight inches long and for all practical purposes are useless.

The straws remaining after harvesting of wheat can be used as animal fodder. Rice straw cannot be used as animal fodder primarily because of its high silica content. If this straw is used as animal fodder, it impacts the quality of milk, with the quantity of calcium in the milk coming down. This is not true about straw left behind after harvesting basmati rice, which has low silica content.

But basmati is grown only in a limited area. Like this year, rice was planted on a total area of 27.36 lakh hectares. Of this, basmati was planted on around 6.5 lakh hectares or 24% of the total area under rice. This was primarily because the government does not buy basmati rice under the minimum support price (MSP) structure. (We shall look at this in detail later).

Farmers have a time of around 10-15 days for removing the rice straw and get the fields ready for planting wheat. The easiest thing in this situation is to burn the rice straw. All it takes is a single well-lit matchstick. The cost is close to zero.

This burning leads to higher pollution and deterioration of air quality even in places hundreds of kilometres away. The heat from burning the rice straw leads to an increase in soil temperature which kills beneficial soil organisms. The burning is also a potential source for greenhouse gases. Also, it is worth remembering that the burning of post-harvest rice stubble forms around 50% of the all the crop residue burning in the country.

Let’s take a look at stubble burning in incidences reported in Punjab and Haryana, where most of the burning takes place.

Source: Price Policy for Kharif Crops – The Marketing Season of 2020-2021, Commission for Agriculture Costs and Prices.

As can be seen from above table, the number of stubble burning incidents have come down over the years. The total number of incidents in Punjab and Haryana have come down by 52% between 2016 and 2019. In 2016, the total number of incidents had stood at 1,18,065. By 2019, this was down to 56,742.

So there has been some improvement on the number of fires front over the years. But there are other ways of looking at the situation; the total weight of the stubble burned and the total area of stubble burned. The Chief Secretary of Punjab Vini Mahajan said on October 31, that the total straw burning area in 2020 was 7.49 lakh hectares, which was 5.23% lower in comparison to 7.90 lakh hectares last year.

A Amarender Reddy, the principal scientist at the ICAR-Central Research Institute for Dryland Agriculture recently wrote in The Wire that last year the farmers burnt 11 million tonnes of rice stubble in Punjab and Haryana. This is a little over 40% of the total stubble of 27 million tonnes of rice stubble produced in both the states. Reddy expects the figure to be the same this year.

There has been some improvement on the paddy burning front. One reason has been the distribution of Happy Seeder, a machine which cuts rice stubble and plants wheat seeds at the same time. Reddy writes that the Punjab government has distributed around 24,000 Happy Seeder machines though the state needs nearly 50,000 seeder machines to remove all the rice stubble in the short period of time available before wheat seeds are planted.

Also, farmers have complained about low germination of wheat seeds when the Happy Seeder machine is used. The central government, like most central governments, has allocated more money to solve the problem. Using this money, machines to tackle the rice stubble can be bought at a subsidy.

While, all this is fine, it doesn’t answer the most basic question: why do semi-arid states like Punjab and Haryana, grow a water-intensive crop like rice paddy in the first place?

Why Punjab and Haryana grow rice?

Punjab has the highest yield of 4,132 kgs per hectare when it comes to rice, against the all India yield of 2,659 kgs per hectare. The rice productivity in Haryana is better than the all India average and is at 3,121 kgs per hectare. But this does not take into account the total amount of water used to produce this rice.

As the document titled The Price Policy for Kharif Crops: The Marketing Season for 2016-17, brought out by the Commission for Agriculture Costs and Prices, points out:

“If water consumption is measured in terms of per kilogram of rice, West Bengal becomes the most efficient state, which consumes 2,169 litres to produce one kg of rice, followed by Assam (2,432 litres) and Karnataka (2,635 litres). The water use is high in Punjab (4,118 litres), Tamil Nadu (4,557 litres) and Uttar Pradesh (4,384 litres). … [This] shows that the most efficient state in terms of land productivity is not necessarily the most efficient if irrigation water is factored into. This is because of high rainfall in the eastern region.”

Haryana also uses a lot of water to grow rice.

What this means is that Punjab and Haryana given that they are semi-arid water deficient areas, should not be growing rice in the first place. In the early sixties, Punjab used to grow crops which did not require a lot of water. These included maize, bajra, pulses, oilseeds etc. But over the years, the share of these crops in the overall cropped area has come down dramatically. Take a look at the following table.

Source: Economic Survey of Punjab, 2019-20.

Rice paddy was grown only on 4.8% of cropped area in 1960-61. In 2018-19 it was grown on around 39.6% of cropped area. What happened here? Sometime in the mid 1960s, the central government launched the Green Revolution in Punjab, in order to build food security in India and reduce our dependence on import of American wheat under the Public Law 480 (PL -480).

The farmers were encouraged to plant a high-yielding variety of wheat. In order to incentivise them, the government bought this wheat from them at a minimum support price (MSP) which was declared every year.

A look at the above table tells us that the cropped area under wheat jumped from 27.3% in 1960-61 to 40.5% in 1970-71. The fact that the government bought the wheat at the MSP, led to an increase in wheat plantation.

The government started buying rice at an MSP as well. This led to a jump in number of farmers planting rice in Punjab and Haryana because they had a readymade customer in the government willing to buy at a fixed price. They weren’t subject to the vagaries of price and India’s underdeveloped agricultural marketing system.

The farmers were first incentivised to grow wheat (rightly) and then incentivised to grow rice as well (right from the point of food security, but wrong from all other angles).

Take a look at the following chart which plots the total amount of area on which rice has been planted in Punjab, over the years.

Source: http://punenvis.nic.in/index3.aspx?sslid=5882&subsublinkid=4993&langid=1&mid=1 and Agricultural Statistics at a Glance 2019.

As can be seen there was a major jump in the area under rice production between 1970-71 and 1990-91, from 0.39 million hectare to 2.02 million hectare. This was primarily because of rice being bought by the government at a minimum support price announced every year. The next jump came in the mid 1990s.

In the year 1997, free electricity for farmers was introduced in Punjab. This encouraged farmers to grow rice even more. They could now pump groundwater for free. This could be used to grow rice. Take a look at the following table, which plots the number of tube wells in the state over the years.

Number of tubewells (in lakhs)

Source: Economic Survey of Punjab, 2019-20.

As can be seen from the above table, the number of electrically operated tube wells has gone up dramatically over the years. In 2018-19, the number is more than 13 lakhs. With free electricity, farmers were incentivised to buy electricity operated tube wells and pump as much ground water as required to grow rice.

This has led to the exploitation of groundwater. As the latest Economic Survey of Punjab points out:

“A state-wise assessment of the groundwater resources in the country showed that 80% of 138 blocks assessed were ‘Over-exploited’, 2 blocks were ‘Critical’, 5 were ‘Semi-Critical’, and 22 were ‘Safe’.”

In fact, 95% of groundwater is extracted for the purpose of irrigation.

Along with this, the Food Corporation of India (FCI) buys up a bulk of the rice produced in the state. It is worth remembering here that Punjab is not much of a rice eating state. Take a look at the following chart.

Procurement of rice in major producing states.


Source: Price Policy for Kharif Crops – The Marketing Season of 2020-21.

In 2018-19, Punjab produced around 12.82 million tonnes of rice. Of this, 11.4 million tonnes was procured by the government through FCI and other state procurement agencies. In Haryana, around 4.5 million tonnes of rice was grown. Of this, around 85% was procured. The major reason for this lies in the fact that given that the green revolution started here, FCI has the best infrastructure to procure and store foodgrains, in this area.

The government doesn’t procure basmati under MSP because there is a huge international demand, given its fragrant smell when cooked. Hence, farmers don’t plant much of it. While there is international demand, the farmers also need to suffer the vagaries of price.

This easy procurement along with free electricity encourages farmers to grow rice in what is largely a semi-arid area. But this still does not explain how the farmers came around to burning rice paddy stubble. I mean, I have been going to Delhi for more than 35 years now, but the city was never dystopian during winters earlier. This is clearly a phenomenon of the last decade. What changed?

What led to farmers burning rice stubble?

As we have seen, the government policies over the years, have incentivised farmers to grow rice. At the same time, these policies have led to the water table in Punjab falling dramatically. Given this, the government had to something about this and it did. (I am talking more about Punjab than Haryana here, simply because the number of fires in Punjab is many times more).

As the Economic Survey of Punjab points out:

“It requires 4,500 litres of water to grow one kg of sathi rice when it is sown in April-May. But if sowing is done around mid-June, water requirement reduces to 1,500-2,000 litres. Water requirement is high in April-May because the evaporation rate is high and there is no rain. As a result, all the water used in irrigation is groundwater. In June-July, rainfall supports water needs of the crop.”

This logic essentially led to the enactment of the Punjab Preservation of Subsoil Water Act in 2009. As per this law, farmers are not allowed to sow paddy seeds in nurseries before May 10. They are not allowed to transplant the saplings before June 10. The idea being that by the time farmers start transplanting the saplings in the fields, the Monsoon would have already arrived and hence, lesser groundwater will be used to grow rice. Haryana has a similar law.

The intention behind the law was noble, but the incentive it created for the farmer was again perverse. The end to end production of rice takes 120 days. The process of growing rice used to start in April earlier. But this was pushed back by a month due to the law to prevent the overexploitation of groundwater.

This led to a situation where farmers were left with a time of around 15 days to get their fields ready for the plantation of wheat. The quickest way to turnaround is to burn the rice stubble and that is precisely what has been happening for the last decade.

History plus perverse incentives are at the heart of this problem.

What’s the way out of this?

The central government recently told the Supreme Court that it was planning to bring a new law to tackle the stubble burning problem. This is a classic way of how any government tries to tackle a long-term problem. They either bring a new law or throw money at it, in the hope of solving the problem.

But the question is will this law or any law be of help? The Punjab government did bring in a law to solve one problem and ended up creating another one, without really solving the first one.

In the short-term, innovations like the Happy Seeder have clearly helped. But the problem can only be solved if the Punjabi and other farmers in the semi-arid areas of North India are incentivised to not grow rice and to grow other crops which do not require a lot of water.

But at the risk of repeating a cliché, it is easier said than done.

Let’s take a look at this pointwise.

1) Over the years, the government has bought much more rice and wheat than it needs to maintain the operational reserve and the strategic reserve. Like in September, the rice stock in the central pool of the FCI was at 22.2 million tonnes. As of October every year, FCI needs to maintain an operational reserve of 8.25 million tonnes and a strategic reserve of 2 million tonnes. Clearly, the FCI has much more rice than is required.

This reserve can be brought down by buying lesser rice in the time to come. If this policy is followed for a few years, the farmers will automatically be disincentivised to grow rice. If they are disincentivised to grow rice, there will be lesser rice stubble to burn.

Of course, this is a politically risky move and in the process a section of farmers is bound to face losses, until they move away from growing rice.

2) Another way is to buy more rice from states like West Bengal, which is best suited to be growing rice, given it uses less water to grow rice, in comparison to other states. In fact, West Bengal produced 16.05 million tonnes of rice in 2018-19. Of this, the government purchased just 1.9 million tonnes. The point to remember here is that West Bengal is a rice eating state.

So, unlike Punjab the government cannot buy almost all the rice that is produced. Hence, buying by the central government shouldn’t lead to a shortage of rice in the state, forcing it to buy rice from other states, in the process. The solution lies in helping increase the rice yield per hectare in the state. In 2018-19, West Bengal produced 2,906 kgs of rice per hectare. This was significantly lower than Punjab’s 4,132 kgs per hectare, but more than the national average of 2,659 kgs per hectare.

3) The most important way in weaning away farmers from rice is to change incentives. Let me offer an analogy here. Why does a wealth manager/insurance agent/personal banker/mutual fund agent mis-sell? Simply because their incentives are so aligned.

Along similar lines, if the farmer has an incentive to grow rice (and unlike financial salesmen, the incentive here is an honest one), he will grow rice. We can’t judge him for this.

One way out is to encourage farmers to grow maize, like they used to in the sixties. In 1960-61, 6.9% of the total cropped area in Punjab was used to grow maize. By 2018-19, this had fallen to 1.4%. As the document titled Price Policy for Kharif Crops—The Marketing Season of 2020-21 points out: “Maize cultivation is more water efficient than rice… [It has] a great potential for crop diversification in rice-wheat cropping system areas of north-western plains, where substantial groundwater depletion has occurred.”

The trouble is that maize has low profitability in comparison to rice “due to low and fluctuating prices and yield of maize.”

As the Price Policy document points out:

“There is a need to find alternative uses of maize in the country for industrial uses like feed, starch and ethanol as well as for direct consumption, mainly value-added products… Allowing maize as raw material for ethanol production would help in crop diversification and ensure remunerative prices to farmers.”

This will help increase the demand for maize and help increase its price.

Along similar lines, there is a need to encourage and incentivise the growing of pulses and oilseeds, which we don’t grow enough of. As the Price Policy document points out:

“Instead of promoting water-intensive crops like rice… it is important to promote production of pulses and oilseeds by encouraging farmers to grow these crops by providing better quality seeds, technology and appropriate price support to address gap between domestic production and consumption and maintain stability in the domestic market.”

The fact of the matter is that the private agriculture markets in the country don’t function well. At the same time, in order to encourage farmers to grow particular crops, the government cannot buy a large amount of it, like it buys rice and wheat, simply because it doesn’t have enough money to do so or the right infrastructure to store what it has bought. Pulses are an excellent example. The reason FCI cannot buy pulses is simply because it doesn’t have the right infrastructure to store them.

In this scenario, getting farmers to grow something other than rice is going to be very difficult and will take a lot of concentrated effort on part of the politicians as well as bureaucrats. Will that happen? On that your guess is as good as mine.

The moral of the story being, just because there is a problem, doesn’t mean it has an immediately implementable solution.